MALAYSIAN APEX COURT DECIDES ON ARBITRABILITY OF DISPUTES INVOLVING A REMEDY OF STATUTORY FORECLOSURE, AND THE INCORPORATION OF ARBITRATION CLAUSES IN MULTI-CONTRACT TRANSACTIONS WHERE ONE CONTRACT CONTAINS AN ENTIRE AGREEMENT CLAUSE

Earlier this year, it was reported that the Malaysian Federal Court on 29 January 2018 decided an application to stay statutory foreclosure proceedings pursuant to a registered security granted over a parcel of land on the basis that the underlying dispute is subject to arbitration in Singapore.  The Federal Court made a ruling with potentially wide-ranging repercussions in the context of the scope of disputes considered arbitrable in Malaysia on the grounds of public policy, and the incorporation of arbitration clauses in multi-contract transactions.

In this post, we consider the decision of the Federal Court in Arch Reinsurance Ltd v Akay Holdings Sdn Bhd [2019] 1 CLJ 305 ("Arch Reinsurance"), its relation to its other apex decisions on arbitration, and its implication for arbitration in Malaysia.

The contract documents

Akay Holdings Sdn Bhd ("Akay") held a mining lease granted by the local government authority over a mine in Pahang.

On 16 May 2013, in order to raise capital to explore and develop the mine, Akay issued secured senior non-convertible bonds under a subscription agreement ("Subscription Agreement") to Arch Reinsurance Ltd ("Arch") at a total price of US$6,000,000.  Annexed to the Subscription Agreement were bond conditions, which provided a timetable for the repayment of the bonds ("Bond Conditions").

As a condition of subscription, Arch sought to secure Akay's obligations under the Subscription Agreement and Bond Conditions by a charge over the mining lease (a form of security for the payment of the loan, which allows Arch to foreclose and sell the lease in the event of default in payment) registrable with the land office under Malaysia's National Land Code ("NLC"), based on the Torrens system of land registration.  The charge was executed and registered in favour of Arch on 5 June 2013 (the "Charge")

Importantly, the Charge contained two clauses:

• Akay shall on demand by Arch duly and punctually pay to Arch the secured amount; and
• if Akay is in default or breach of any terms, Arch shall thereafter have the right to exercise any remedies available, including remedies of sale and possession under the National Land Code and civil suit to recover all monies due and owing to the charge.

The dispute resolution clauses

The Subscription Agreement and Bond Agreement each contained an arbitration clause which provided that:

• any dispute arising out of the Subscription Agreement or the Bond Conditions shall be resolved through friendly consultations in good faith;
• in the event the dispute is not resolved within 10 business days of the commencement of consultations, any dispute arising out of the Subscription Agreement shall be settled by arbitration in Singapore under the SIAC Arbitration Rules; and
• Singapore law as the governing law.

(the "Arbitration Agreement")

The Charge, however, contained a different dispute resolution clause.  The Charge provided that:

• parties submit to the non-exclusive jurisdiction of the Malaysian courts; and
• Malaysian law as the governing law.

The dispute

The maturity date of the bonds was 23 May 2014, within which Akay shall redeem the bonds.  Under the Bond Conditions, a default in the payment of the principal or premium of the bonds occurs in the event of non-payment on the maturity date.  Upon default of such payment, Akay is entitled, at its discretion, to enforce the repayment of the bond.

Akay was unable to redeem the bonds at the original maturity date.  At Akay's request, the maturity date was extended from 23 May 2014 to 22 August 2014, on the basis of ongoing talks and due diligence necessary to sell the mining lease to a potential buyer.  When Akay again failed to redeem the bonds on 22 August 2014, Arch agreed to extend the maturity date to 15 December 2014 for the potential buyer to complete its due diligence and facilitate the sale of the mining lease.

Akay sought a further extension of time, which was rejected by Arch.  Between December 2014 to January 2015, Akay and Arch's solicitors engaged in written correspondence, with Arch demanding that it be paid the entire secured amount, and Akay alleging that Arch reneged on its purported representation to provide a further extension of time to facilitate the sale of the mining lease.

In the face of Akay's continued default, on 22 January 2015, Arch issued a statutory notice of demand under section 254 of the NLC (known as 'Form 16D'), requiring Akay to remedy the breach of the Bond Conditions forthwith, failing which Arch shall apply to the Malaysian court for an order for sale of the leasehold by public auction.  Akay disputed that there was an event of default by way of its solicitor's letter on 13 February 2015

The application to stay litigation proceedings in the Malaysian High Court of Appeal

Arch proceeded to issue foreclosure proceedings in the Malaysian High Court for an order for sale under section 256 of the NLC.  For background, the statutory foreclosure proceedings – which is designed to be "speedy and summary in nature", can be commenced under the NLC where there is a default in the terms of the registered charge.  Commonly, this would be a default in the repayment of a loan secured by the charge.  A lender (or chargee), on default in repayment, may commence foreclosure proceedings to obtain a court order for sale of the property charged by way of public auction.  According to the Federal Court in Low Lee Lian v Ban Hin Lee Bank Bhd [1997] 2 CLJ 36, a debtor (or chargor) cannot successfully resist foreclosure proceedings by alleging breaches by the chargee of the loan agreement or the terms of the annexure to the charge. Rather, a chargor can only resist foreclosure by showing a "cause to the contrary" under section 256(3) of the NLC, which has been judicially defined as being any one of the following exhaustive categories:

• an exception to the doctrine of indefeasibility of title under section 340 of the NLC applies;
• the chargee has failed to meet the conditions precedent for making an application for an order for sale, i.e. failing to effect a valid statutory notice of demand ('Form 16D') prior to issue of statutory foreclosure proceedings; or
• the grant of an order for sale would be contrary to some rule of law or equity.

In response, Akay filed an application with the Malaysian High Court for a stay of court proceedings under section 10 of the Arbitration Act 2005 ("AA"), which bears resemblance to Article 8 of the UNCITRAL Model Law.  According to Section 10(1), a court before which proceedings are brought in respect of a matter which is the subject of an arbitration agreement shall, where a party makes an application before taking any other steps in the proceedings, stay those proceedings and refer the parties to arbitration unless it finds that the agreement is null and void, inoperative or incapable of being performed.  Akay contended that the underlying dispute over the default must first be resolved by arbitration before the respondent could commence foreclosure proceedings.

According to Akay, Arch misrepresented its amenability to further extensions of time to allow Akay to sell the mining lease, and by refusing to grant an additional extension of time, Arch had frustrated the potential sale of the mining lease. This, according to Akay, was a repudiatory breach of Subscription Agreement.  Arch denied having made such representations.

The High Court dismissed Akay's application for a stay of foreclosure proceedings, on the basis that a registered charge under the NLC, which concerns a claim in rem as opposed to a claim in personam, cannot form the subject of a stay application under section 10 of the AA.  The High Court found that the determination of a breach of the Subscription Agreement or the Bond Conditions is not a prerequisite for the making of a claim in rem under the NLC.

Appeal to the Court of Appeal

On appeal, the Court of Appeal reversed the decision of the High Court, finding that the foreclosure proceedings cannot take place without first resolving the dispute as to the alleged breach of the Subscription Agreement by arbitration.  According to the Court of Appeal, the High Court ignored the commercial reality and circumstances which led to the creation of the Charge; which "very existence was anchored on the subscription agreement and bond conditions and to ignore such fundamental nature of the whole scheme of things would invariably lead to a wrong construction of the terms and conditions of the three agreements as was in this case."  The Court of Appeal, "applying a common sense approach" in construing the contract documents, came to the "irresistible conclusion that the three documents are indeed interlocked together and they cannot be severed".

Concluding that there existed a dispute which must first be arbitrated, the Court of Appeal held that:

"[t]he upshot of it all was simply that the subject matter of dispute in the Charge was the very subject matter in dispute in the Subscription Agreement and Bond Conditions.  That being the case and since there is no arbitral finding that there has been a breach of the Subscription Agreement and [Bond Conditions] by [Akay], any action pursuant to the Charge is premature … [T]o say that [Arch] was exercising its right in rem was in fact "putting the cart before the horse" so to speak.  [Arch] can only possess that right in "rem" when [Akay] had been found by an arbitral tribunal to be in breach of the Subscription Agreement and Bond Conditions.  The learned judge fell into error … when he did not treat the interlocking nature of the three documents."

Appeal to the Federal Court

On appeal to the Federal Court, three questions of law were decided by the Federal Court:

• Whether section 10 of the AA applies to a registered charge providing for its own mechanism of enforcement under the NLC?
• Whether a default under a registered charge entitling the chargee to commence foreclosure proceedings can be made the subject of arbitration proceedings; and
• Whether the dispute on liability said to arise from the contract documents must be determined as a prior issue under the arbitration clauses contained in the Subscription Agreement and Bond Conditions before a registered chargee is entitled to commence foreclosure proceedings under the NLC, notwithstanding that the Charge is subject to the non-exclusive jurisdiction of the Malaysian courts?

Notwithstanding the somewhat overlapping questions, there were essentially only two issues: (i) whether the dispute underlying the Charge fell within the scope of the Arbitration Agreement; and (ii) whether a dispute underlying a registered charge sought to be statutorily enforced by statutory foreclosure proceedings is objectively arbitrable under Malaysian law.  The Federal Court reversed the findings of the Court of Appeal, broadly on two grounds:

• that the dispute underlying the Charge is separated from the Subscription Agreement and Bond Conditions as a result of an entire agreement clause in the Charge; and
• that a dispute underlying a statutory foreclosure proceedings under the NLC is non-arbitrable as being contrary to public policy.

We examine the reasoning of the Federal Court in detail below.

Entire agreement clause

The Federal Court disagreed with the finding of the Court of Appeal that the contract documents were interlocked to form a single transaction.  According to the Federal Court, this was primarily based on two findings, i.e. that the Charge was executed after the Subscription Agreement, and that an entire agreement clause had essentially locked out the Arbitration Agreement from any matter relating to the Charge:

"[T]he charge is a separate and distinct document by itself … It was executed after the subscription agreement.  There is a clause in the subscription agreement, namely, cl. 19 which declares that the subscription agreement constitutes the entire agreement between the parties and therefore the charge cannot be construed as being subject to the subscription agreement."

Clause 19.1 read

"This Agreement constitutes the entire agreement between the Parties with respect to the transactions contemplated in this Agreement and supersedes all prior oral and written agreement, memoranda, understandings, undertakings, representations and warranties between the Parties relating to the subject matter of this Agreement".

The Federal Court found that there was clear intention by the parties – according to the Subscription Agreement and the Bond Conditions – that Arch could enforce the security under the Charge in the event of default by Akay, on the basis that there was no agreement in the Subscription Agreement and Bond Conditions that a dispute as to the enforcement of the security under the Charge must first be determined by arbitration.  Instead, the dispute resolution clause in the Charge took precedence, primarily as a result of the entire agreement clause.

Non-arbitrability of an underlying dispute which is subject to a statutory remedy

Section 4 of the AA provides that any dispute which parties have agreed to submit to arbitration under an arbitration agreement may be determined by arbitration unless the arbitration agreement is contrary to public policy (the 2018 amendment to the AA now extends non-arbitrability to subject matter which "is not capable of settlement by arbitration under the laws of Malaysia".  This case was decided prior to this amendment).

Prior to this case, the Federal Court observed that there are no decided cases on the issue of arbitrability under section 4 of the AA in Malaysia, and was referred to cases from the Australian, English and Singaporean courts on objective arbitrability.  Referring instead to Malaysian case law which determined the status of a registered chargee under the NLC, the Federal Court held that:

"[t]he NLC is a complete and comprehensive code of law governing the tenure of land in Malaysia and the incidence of it as well as other important matters affecting land … [T]he provisions of the NLC setting out the rights and remedies of parties under a statutory charge over land … are exhaustive and exclusive and any attempt at contracting out of those rights unless expressly voided for in the Code – would be void as being contrary to public policy. Hence, the dispute triggered by the statutory notice of demand in Form 16D is not arbitrable under s. 4(1) of the Arbitration Act 2005."

According to the Federal Court, the dispute is non-arbitrable on the basis of public policy; the statutory right of a chargee to indefeasible title and to sell charged security in the event of default by a chargor cannot be curtailed by private agreement, any attempt to do so would be a breach of public policy.

Interplay with other decisions of the Federal Court

The decision of the Federal Court in Arch Reinsurance, while providing some answers to questions which were once left unanswered, have also raised some questions which are left unanswered.

The decision of the Federal Court in Press Metal Sarawak Sdn Bhd v Etiqa Takaful Bhd [2016] 9 CLJ 1 ("Press Metal") affirmed Malaysia's liberal and commercial approach to construing the scope of arbitration agreements:

"In determining what is the dispute or difference the parties intended to submit to arbitration, the arbitration clause ought to be interpreted widely, based on its express terms and the intention of the parties, taking into consideration the commercial reality and the purpose for which the contract or agreement was made. A proper approach to construction requires the court to give effect, so far as the language used by the parties in the arbitration clause will permit, to the commercial purpose of the arbitration clause."

In Arch Reinsurance, while the Court of Appeal recognised the commercial nature of the transaction (given that the charge could not have been registered the same day the parties executed the Subscription Agreement), it appears that the Federal Court's focus was on the existence of the entire agreement clause and the fact that the Charge was executed some time after the Subscription Agreement, even though it was not disputed that the Charge was created as a condition of the Subscription Agreement.

It also appears to be the case that the question of the arbitrability of a dispute is to be taken at the hearing of an application to stay litigation proceedings, and not referred to arbitration, as was the general position by the Federal Court in Press Metal.  In Press Metal, the Federal Court considered that where a question of law cannot be decided without ascertaining facts, a stay of proceedings will be ordered.  Questions on the scope of an arbitration agreement and objective arbitrability are essentially questions of law which do not require factual determination.

Another pertinent question is whether the Federal Court was correct in applying Malaysian law to determine the dispute relating to the scope of the Arbitration Agreement, which inevitably required a consideration of the principles of contractual interpretation of arbitration clauses.  In Thai-Lao Lignite Co Ltd & Anor v Government of the Lao People's Democratic Republic [2017] 9 CLJ 273 ("Thai-Lao Lignite"), the Federal Court held that in the absence of an express choice of law to govern an arbitration, all else being equal, the stipulation of Malaysia as the seat is deemed a tacit agreement that the law applicable to the arbitration agreement is Malaysian law.  We understand it to be the case that the Federal Court in Thai-Lao Lignite delivered its grounds of judgment on 17 August 2017, long after the conclusion of the hearing in Arch Reinsurance.

In Arch Reinsurance, the Arbitration Agreement provided for Singapore as the seat of arbitration and governing law.  Assuming Singapore law applied, would it have been the correct approach to construe matters relating to the scope of the Arbitration Agreement under Singapore law?  Taking a step further, with the benefit of hindsight, should Akay have further sought a stay of the dispute surrounding Akay's application to stay litigation proceedings for forum non conveniens, i.e. that the Singapore courts is the more appropriate forum to hear the dispute surrounding the interpretation of the Arbitration Agreements?  After all, both the law of the arbitration agreement and the seat of the arbitration is Singapore.

Assuming that the Singapore law should have been applied as the law governing the Arbitration Agreement, what then is the law applicable to the question of objective arbitrability?  According to Hanotiau, it is in principle better to apply the national law of the court determining the case, even if it has been decided by various courts before that arbitrability should be determined by the law applicable to the validity of the arbitration agreement (see, e.g. Company M v M SA (Court of Appeal of Brussels, 4 October 1985, (1989) XVI Yearbook of Commercial Arbitration 619).  If the dispute were taken to Singapore on the basis of forum non conveniens, the complexity will inevitably intensify: should a Singapore court consider its own principles of objective arbitrability as on the basis of lex arbitri, of the law governing the arbitration agreement, or perhaps that of Malaysia, because Malaysia is the forum to which the enforcement of the statutory remedy is sought?

Lessons from Arch Reinsurance

The Federal Court held that "[u]nder the NLC, the power to make an order for sale of the said security by public auction is vested with the court ".  This much is uncontroversial, as it is generally accepted that certain statutory remedies are only available by way of court order, such as an order to wind up a company.  The fact that a remedy may not be available from an arbitrator is not a ground to render a dispute non-arbitrable (see, e.g. Goh Nguang Chian v Dynapack Eoss Packaging Sdn Bhd [2018] 1 LNS 937).  However, the Federal Court determined here that a dispute underlying a petition for statutory remedy is non-arbitrable, finding that "[i]t is for the court, and not the arbitrator, to decide whether there is a breach of the terms of the charge."  This has narrowed the scope of arbitrable disputes in Malaysia, and users of arbitration will need to reassess the arbitrability of particular disputes which can arise in their transactions.

The decision of the Federal Court underscores the difficulty associated with the arbitrability of disputes arising under a security agreement in cross-border transactions, against the backdrop of diverse local laws on arbitrability and security transactions across different countries.  This has led to the development of the UNCITRAL Model Law on Secured Transactions (2016), which provides in Article 3(3) that parties to a security agreement may agree to resolve any dispute between them by arbitration.  This is, however, conditional upon local laws allowing the use of arbitration in matters of secured transaction.  In Malaysia, section 4(2) of provides that "[t]he fact that any written laws confers jurisdiction in respect of any matter on any court … but does not refer to the determination of that matter by arbitration shall not, by itself, indicate that a dispute about the matter is not capable of determination by arbitration."  The NLC does not expressly prohibit arbitration, but the Malaysian courts have interpreted this silence as prohibiting arbitration for secured transactions.

This case also reinforces the need to draft arbitration clauses carefully for transactions consisting of multiple contractual documents.  In this case, adopting a boilerplate entire agreement clause was ultimately detrimental to the scope of the arbitration clause.  It is important to consider arbitration clauses carefully, and to determine at the outset whether these clauses can be upheld in the jurisdictions where a transaction has a connection.

For further information, please contact Peter Godwin, Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur, Daniel Chua, Associate, or your usual Herbert Smith Freehills contact.